Purpose

This aide-memoire is designed to help us consider the risk of fraudulent financial reporting, our
response to such risk and plan appropriate audit procedures. It should be used as a brainstorming tool
to help facilitate discussions with management and audit team discussions about the susceptibility of
the entity to material misstatements in the financial statements resulting from fraudulent financial
reporting. We document our findings in the Fraud Risk Document.

Section A: Fraudulent financial reporting big picture fraud risk factors

Section A of the aide-memoire helps you identify big picture events or conditions that may lead to
fraudulent financial reporting which we refer to as fraud risk factors. It also focuses on control and
oversight issues how the client manages fraud risk. These issues may also give rise to fraud risk
factors which we discuss with management and those charged with governance.
We document management discussions in Section I of the Fraud Risk Document. We document the
fraud risk factors related to fraudulent financial reporting in Section II of the Fraud Risk Document.
For fraud risk relating to misappropriation of assets, we refer to the relevant factors in the X Audit
Manual (X).

Section B: Fraudulent financial reporting Issues relating to specific audit areas

Once we understand the big picture view of the fraudulent financial reporting risk factors, we use
Section B of the aide-memoire to consider where errors may be more likely to occur or how fraud may
be perpetrated at the client.
The summary page on B1 should be used as a brainstorming tool to help audit team members:

understand how there could be several forms of accounts manipulation spanning a number of areas
and how it may affect different aspects of the audit.

understand the need to involve specialists and/or assign experienced audit team members in areas
of higher risk.

gain a better understanding of how fraudulent financial reporting could occur at the entity and in
the specific areas assigned to them.

B2 provides examples of how fraud may be perpetrated in these specific areas.

It is not a
comprehensive list of all examples at a particular entity nor will it apply to all client circumstances.
Section B and C assists in planning our response to the fraud risk factors as documented in Section II
of the Fraud Risk Document. We also refer to the example responses in the X.

Section C: Fraudulent financial reporting Specific issues and possible responses

Section C of the aide-memoire highlights certain issues from Section B and provides some easy to do
audit procedures if:

we have identified a fraud risk factor related to fraudulent financial reporting in one of
these specific areas or;

if we come across circumstances during our audit that may indicate that there could be a
material misstatement resulting from fraud.

Section C assists in planning our response to the fraud risk factors as documented in Sections II of the
Fraud Risk Document. It may also assist in designing additional procedures where we encounter
circumstances that indicate a possibility of material fraud. We also refer to the example circumstances
and responses in the X as documented in Section III of the Fraud Risk Document. We also refer to the
example circumstances and responses in the X.

01/G/1-1

Section A: Fraudulent financial reporting - big picture fraud risk factors

MP
Lack of trust / poor auditor
relationship
Concerns re: lies, deception,
manipulative behaviour.
Unreasonable audit demands,
constraints, timings

MP
Dominance / lifestyle issues
Management dominated by
one person or small group.
Aggressive management style.
Lavish lifestyles

MP
Undue secrecy
Undue secrecy over routine
matters. Long delays in
obtaining information. Access
limitations. Significant matters
not previously disclosed.

MP
Illegal / unethical practices
Anti-trust abuse / fines.
Unethical practices eg in
developing markets.
Disregard for regulatory
authorities

MP
Significant director share
sales
Does the director know
something the market does
not? The spin for analysts may
be misleading.

EBD
High analyst or other
pressures
High analyst expectations or
pressures eg following
acquisition. Pressure to
understate results eg for tax
reasons

EBD
Declining industry /
earnings
Market saturation.
Technological or product
obsolescence. Threat of
insolvency, hostile takeover,
etc.

EBD
High hope value
High share price based on
successful outcome of contract
award, product test results,
market research, etc

PP
Aggressive forecasts
Unduly aggressive financial
targets & expectations for
management, eg linked to
rights issues, takeovers, etc.

PP
Highly-leveraged rewards
Unrealistically aggressive sales
or profitability incentives
leading to advancing, or
deferral, of sales / profits

BP
Aggressive accounting
policies
Early income recognition, cost
deferral, etc. Also vague
accounting policies facilitating
manipulation and smoothing

BP
Unique products unique
risks
Products no-one else can
offer hidden risks, eg
guaranteed annuity rights. No
track record. Products subject
to rapid change

BP
Cash / funding gap
Cash v profits gap. Inability to
generate cash flows. Pressure
to obtain more capital. High
debt dependency.

BP
Results exceed market
trend
Results out of line with market
or other business units (eg
meets budget when others
struggle). Budgets matched
too closely

BS
High management turnover
Manipulation has become
untenable or management
want to avoid becoming
involved. Also high adviser
turnover

BS
Profit warnings / credit
warnings
Often a sub-plot to profits
warnings or credit warnings.
Manipulation likely to be
exposed when profits
squeezed

BS
Complex corporate
structures
Unwarranted complexity in
structures. Bottlenecks with
reporting through one
individual. Poor
accountabilities.

BS
Related party
arrangements
Web of companies owned by
or linked to key individuals in
the business. Significant
related party transactions.

BS
Multiple banking
arrangements
Over complex banking
arrangements for size of
group. Enables manipulation

BS
Remote operations
Poor management oversight of
remote subsidiaries and JVs eg
remote units managed by
autocratic CEO with direct
report to group level.

Control and oversight issues to be discussed with management and those charged with governance
BS

BS

Poor focus on manipulation

and fraud risk
Key risks not identified or
understood. No challenge of
results reported. Poor focus on
vulnerable assets.

Poor corporate
governance /
internal control
Weak / non-existent non-execs.
Failure to address financial
reporting needs and/or major
weaknesses in control. Poor
segregation of duties.

BP

Lack of support for key

figures / significant
estimates
Lack of analysis. Significant
estimates involving subjective
judgements or uncertainty or
unusual or highly complex
transactions close to year end

PP

Poor director /
management vetting
Failure to check out career
histories properly for directors,
managers and other sensitive
positions

BS

No whistle blowing
channels
No channels for employees to
report suspicions about senior
management eg to chairman
of the Audit Committee

EBD External business drivers, BS Business structure, MP Management philosophy & operating style, PP Personnel policies and practices, BP Business performance

Section B1: Fraudulent financial reporting wheel

Misuse of merger
reserves
Suppressed or false claims
Manipulation of transfer pricing

False sales and debtors

Advancing or delaying revenue
Manipulation of rebates and discounts

Manipulation of joint ventures

Misrepresentation of credit status

Bad debt under or over provision

Misvaluation of other assets

Misuse of inter-company
and suspense accounts

Othe
r
Cas
h

False cash entries

Revenu
e

Inventor
y

Hidden pledges of cash deposits

Teeming and lading

Under or over accruals

Expense
s

Delaying or advancing
expenses
Manipulation of
rebates
and discounts
Misrecording capital or
revenue items
Hidden contract
terms

Standard cost manipulation

False ownership status
False
quality

False
quantity

False
valuatio
n

Section B2: Fraudulent financial reporting - specific examples

Revenue

Expenses

Inventory

False sales/debtors

Advancing or
delaying revenue

Manipulation of
rebates/discounts

Misrepresentation of
credit status

Bad debt under or

over provision

False sales
Fake customers
Sales to connected
parties
Kickbacks to customers
Overcharging customers

Sales recognised on
basis of order
Collusive pre-invoicing
Undisclosed sale or
return
Trade loading
Stocks allocated to 3rd
party warehouses
under control

Rebates/discounts not
accrued or hidden
agreements
Credits hidden in price
manipulation in
following year
Stock taken back at full
valuation
Debits/credits
transferred to fake
account for write off
later

False information on
initial credit status to
induce sales to poor
risks
Suppression of credit
information
Bribery of credit control
staff

False representation of
current status
Recycled funds give
appearance account is
current
Manipulation of debtor
ageing

Under or over
accruals

Delaying or
advancing expenses

Manipulation of
rebates/discounts

Misrecording capital
or revenue items

Hidden contract
terms

Under accruals,
reversal of accruals
False accruals
Accruing actual to
budget
Forward purchase
orders
Cost of goods
over/under stated
False consulting
contracts

Non-standard payment
terms to compensate
for reduced or inflated
prices
Misrepresentation of
creditor ageing
Teeming and lading of
suppliers

Rebates taken to profit

early
Extra charges against
rebates later
Postponed charges
Hidden agreements

False sale and

leaseback
Hiding capital items in
revenue or revenue
items in capital
Allocating costs in
contravention of
accounting policies

Hidden conditions and

terms that impact
results
Side letters to advance
or delay income or
expense recognition

False valuation

False quantity

False quality

False status

Standard cost
manipulation

Over/under valuation of
raw material
inventory
Over/under valuation of
WIP
Losses on unprofitable
contracts credited
against WIP on
profitable contracts

Stock already sold or

leased included in
count
Borrowed stock
Forged quantities at
stock take
Cut-off manipulation
Empty boxes included
in pallets

False documents re
quality of stock
Suppression of adverse
stock quality data

Forged information on
prospects of disposal
Misrepresentation of
ownership status

Manipulation of price
and other inputs to
standard costings
Standard cost changes
inconsistent with
changes in selling
price/general costs

Section B2: Fraudulent financial reporting - specific examples (contd)

Cash

Other

False cash entries

Hidden pledges for

cash deposits

Teeming and lading

Cash washing
creating illusion of
cash movements
Rigged bank
reconciliations
Recycling funds
through
subsidiaries, JVs
and other
connected parties

Hidden pledges in
return for
temporary cash
flow

Teeming and lading

or cash in transit
Teeming and lading,
creating
unauthorised
overdrafts

Misuse of inter-co
& suspense a/cs

Misvaluation of
other assets

Manipulation of
joint ventures

Manipulation of
transfer pricing

Suppressed or false
claims

Hiding transfers to
and from merger
reserves
Items in suspense
between intercompany accounts
Hiding any form of
manipulation in
suspense accounts

False valuation of
fixed or intangible
assets
Suppression of test or
research data that
undermines a
valuation or
forecast

Parking items in joint

ventures over the
year end
Transactions to
inflate or depress
revenue or
expenses

Profits shifting
Assets exchanged for
shares at inflated
values
Values increased or
decreased by
moving assets
round group
Assets acquired with
concealed or
understated
liabilities

Suppression of
claims
False or forged
information relating
to existence, status
or value

Misuse of merger
reserves
False credits from
merger reserves to
P&L
Hiding false debits in
merger reserves
Over providing
merger reserve
items

Section C: Fraudulent financial reporting specific issues and possible

responses
Same (or next day), equal and
opposite debits and credits
washing through cash
accounts. Payments to odd
locations. Vague
payee/details

Cash washing

Rigged bank
reconciliations

Cash/profits trend
mismatch

Dubious inter-company
traffic

Balance sheet nos. cant

be substantiated

Cash book or bank statement

balances do not agree with
balances on recs. Eg False
formula in bank rec
spreadsheet, etc

No cash flow analysis. Cash

flow analysis in pack does not
agree with actual cash
movements. Loose group
funding arrangements

Manipulation differences may

be shifted between cash and
inter-company balances.
Interco used to conceal other
false entries, eg from merger
reserves

So often the evidence for

accounts manipulation is
sitting in the balance sheet in
the routine transactions

Suspense account
traffic

Period 13 override
adjustments

Unsupported journals

The word on the street

Group or divisional
management put through
entries that override business
unit results. Batches of
journals requested to be put
through in business units.

People know a lot eg Wickes

retail staff knew about the two
sets of agreements, inventory
staff may know about new 3rd
party warehouses

Separate nominal ledger

for head office

Dubious transactions going

through in year although
apparently cleared at year
end. Unreconciled balances

Manipulation cases often

involve improper journals.

Sometimes head office nominal

ledgers include fake entries
and may be closely guarded

Missing or bizarre
margin analysis

Misuse of merger
reserves

Group or business unit

margins that exceed the
market trend.

Fake credits to P&L with origin

concealed by fake intercompany and suspense
account entries. Also used to
hide false debits

Managers never away

Beware the controller (or
manager) who never takes
holiday or never misses a
month end. A high risk whether
or not he is cooking the books.

Authority without
knowledge

Input of FD/FC to
numbers

For example, chairman or

director signs payments but
does not know detail or
question too much

High level of input or revision

of numbers. Adjustments
which only the FD knows about

Rigged bank
reconciliations

Cash/profits trend
mismatch

Dubious inter-company
traffic

Balance sheet nos. cant

be substantiated

Check off balances picked up.

Flip over to the formulae and
review (eg sum of + 500,000)

Check out credibility of cash

analysis in management
accounts.

Review some inter-company

account traffic against what
you expect to find. Spot check
some balances at year end.

Suspect problems in providing

analyses of debtor or creditor
balances, eg bills of exchange
analysis

Separate nominal ledger

for head office

Responses
Cash washing
Turn the pages of the cash
book or set up a simple
program to do so

Suspense account
traffic

Period 13 override
adjustments

Manager review of suspense

account traffic during the
year. Get explanations and
support

Look very hard at adjustments

made above business unit
level and the reasons

Missing or bizarre
margin analysis

Misuse of merger
reserves

Unsupported journals

The word on the street

Where there appears to be an

excessive number of journals
take some batches of journals
and seek explanations and
supporting documentation

Get out and about. Talk

informally to process owners,
etc

Managers never away

Authority without
knowledge

Examine entries carefully in

such ledgers

Input of FD/FC to
numbers

If group has asked for a

detailed margin analysis,
check it out. If not, ask for
one.

Check out new items credited

and debited and follow through
to ultimate
destinations/origins.

Regard excessively
conscientious controllers (or
managers) with suspicion.

Review payments signed only

by directors, esp those where
you would expect a lower
signatory

Identify entries put through

after close of the ledgers by FD
or FC, or directed by them